Will the Recent Correction Cause a Recession?

The U.S. stock market is off to the worst start to a year ever as fears regarding the Chinese stock market put downward pressure on stock markets worldwide. Hedge fund billionaire George Soros further added to the fears by saying that the correction resembles the recession of 2008. With Chinese stock market falling by 5% again today, it looks like the U.S. market will head lower today as well.

I have been bearish on the market for quite some time now and I have been recommending investors to short many stocks over the last few months. Many analysts believe that a recession is overdue and this has left many investors questioning will this crash result in a recession.

However, given the rarity of such events, it is impossible for anyone to correctly predict recessions. A recession won’t happen just because it is long overdue. As of now, I don’t think there is any reason for investors to worry about a recession, however, I do think the market will continue moving lower due to several reasons as mentioned below.

Chinese Bubble

The Chinese stock market bubble has finally begun to pop. The flash crash is August was a warning and the consistent decline highlights the fact that the bubble has started popping. China is the world’s second largest economy and it is estimated that it will soon overtake the U.S. However, due to the restrictions applied by the Chinese government to keep its money within its borders, the people in China have been left with only two investment option—real estate and stock . As a result, the stock market has become very expensive over the last few years. With many stocks trading at bubble-like valuation, investors can expect the stock market’s downfall to continue. To put in perspective, if Chinese stocks fall 70% from here, then their P/E ratios will be in line with current U.S. P/E ratios.

Unemployment

The U.S. unemployment rate has been falling consistently and is at the lowest level since last financial crisis. The numbers look rosy, however they hide many important facts. First off, the unemployment rate doesn’t include employees working at low-pay temporary jobs to make ends meet. While the quantity of the jobs has increase, the quality is still depressed as the average wage of employees has remained stagnant.

Conclusion

No one can accurately predict a recession, however investors can prepare for it by proper hedging. Having 60% of your portfolio short with overvalued companies can help investors benefit from the ongoing correction. Since, I expect the market to continue its downtrend, I would recommend investors to follow long/short strategy.